Using the appropriate bid or ask rates for the Euro/US$ and the British pound/US$, and assuming the Euro/British pound rate is 0.4000/₤, what will be the profits from triangular arbitrage, starting with 1,000? Euro / = 1 - 1.0015 British Pound / $ = 2 - 2.01 A) $243.78. B) $0. C) 250. I am posting the answers because I have two questions: 1) how do we know to go from to Euros to Pounds, and back to dollars? 2) in the solution, the first step is to sell Dollars and buy Euros. Why do we buy the Euros at the BID price? (note: later, when we buy Dollars with the Pounds, we pay the ask price) __________ The correct answer was A. Start with $1,000. Use the $1,000 to buy euros (1,000 × 1.000/) = 1,000. Use the 1,000 to buy sterling (1,000 / 0.4000/₤) = ₤2,500. Use the ₤2,500 to buy dollars (₤2,500 / ₤2.0100/$) = $1,243.78. Arbitrage profit = $1,243.78 − $1,000 = $243.78
I’m sorry, the Euro/British pound rate is 0.4000/British Pound.
use the search button to get the full explanation. but to answer your answers… 1) write out all the exchange rates and their spreads. since u are investing dollars, the exchange rates that involve will be assumed to be "correct." calculate the implied cross rate EUR/GBP, giving u the intrinsic value. to calculate the implied cross rate EUR/GBP, u gotta make sure the GBP/USD is inverted, interchanging its bid and ask prices because u are looking at it from the indirect perspective when u invert. if the intrinsic value is higher than the given market rate, the base currency (GBP) is undervalued. buy undervalued GBP, sell overvalued GBP. The order is , overvalued, undervalued, . in other words, , EUR, GBP,$ 2) theres something called the bid ask matrix. once u had an algebraically sound exchange rates that give u the implied cross exchange rate EUR/GBP, u look at the base currencies of the exchange rates (not including the implied cross rate). if base currencies are different cross Bid: Bid *Bid Cross Ask: Ask*Ask if base currencies are same cross bid: bid/ask cross ask: ask/bid
many thanks
CFA.Rhythm Wrote: ------------------------------------------------------- > Using the appropriate bid or ask rates for the > Euro/US$ and the British pound/US$, and assuming > the Euro/British pound rate is 0.4000/₤, > what will be the profits from triangular > arbitrage, starting with 1,000? \> \> Euro / = 1 - 1.0015 > > British Pound / $ = 2 - 2.01 > > A) $243.78. > > B) $0. > > C) 250. \> \> \> \> I am posting the answers because I have two \> questions: \> \> 1) how do we know to go from to Euros to Pounds, > and back to dollars? > > 2) in the solution, the first step is to sell > Dollars and buy Euros. Why do we buy the Euros at > the BID price? (note: later, when we buy Dollars > with the Pounds, we pay the ask price) > > __________ > > The correct answer was A. > > Start with $1,000. > > Use the $1,000 to buy euros (1,000 × 1.000/) = > 1,000. > > Use the 1,000 to buy sterling (1,000 / > 0.4000/₤) = ₤2,500. > > Use the ₤2,500 to buy dollars (₤2,500 > / ₤2.0100/$) = $1,243.78. > > Arbitrage profit = $1,243.78 − $1,000 = > $243.78 have you not read schweser yet!? UP THE BID DOWN THE ASK!!!
It always helped to remeber that with triangular arbitrage, if its (-) you went the wrong way, if its 0 there no possibility so go the other way.